Custom Developed Computer Systems: Who should Own What and Why – A Survey of Business and Legal Considerations

“I’m paying you to develop this system and I don’t own it all?”

Software developers/system integrators often hear this question from their clients for whom they develop large-scale custom computer systems. But the issues of ownership is rarely an all-or-nothing proposition.

A major system development effort often involves the integration of custom-developed software with existing programs, either proprietary to the developer, the client or a third party. The developer, acting as system integrator, typically:

creates the necessary custom software

procures required third party proprietary software (perhaps providing its own as well) and hardware

puts them all together so they work.

This article assumes that legal counsel is involved and is well-versed in computer and intellectual property law, and that a written contract will result. The absence of a written agreement guarantees uncertainty over critical ownership issues and invites future conflict.

The developer’s client expects its system investment to provide a competitive advantage. It feels it must “own” the system to restrict the developer from creating a similar one for its competitors. This often entails prohibiting the developer from further using any new system development techniques it may have acquired while working for the client. The developer, on the other hand, will want to use elsewhere the processes, techniques and know-how underlying the code created for the client and, possibly, the code itself.

How Should These Opposing Positions Be Reconciled?

Custom Developed Code

Software in source and object code form is copyrightable as a literary work. 1 Ownership of the copyright vests initially in the work’s author.2 Since the developer will usually be an independent contractor, not an employee of the client, the custom software it creates is not a work made for hire automatically owned by the client as employer. Absent a written assignment, and because software is not among the items deemed works made for hire under the Copyright Act, the developer arguably owns the copyright.3

Nevertheless, the client often expects to own the copyright. The developer, meanwhile, may wish to reuse the code for other purposes, believing it owns the copyright. Clearly, this issue must be resolved and stated in the written agreement. If it is not, further assignment of the code to a third party by the developer may result in a very upset client, and worse, a legal dispute.

Copyright law protects the physical code (and documentation), not the underlying ideas. The copyright owner, has the exclusive right to copy, distribute and modify the software.4 In general, development agreements grant the copyright to the client, who reasonably expects to have exclusive rights for the fees it pays the developer. (Copyright is one of the more obvious attributes of ownership.) The developer may wish to negotiate retention of the copyright in order to license the actual or modified code to others or use it to develop further software for its own purposes. As an inducement to the client, the developer might reduce its development fees.

In addition to the copyright, the client will often seek to own all concepts, techniques and know-how underlying the software, precluding the developer from adding to its knowledge base what it learned while working for the client. Sometimes, the developer’s pre-existing proprietary concepts will be excluded from the ownership grant and the client licensed to use them.

Granting the client ownership of all intellectual property rights underlying the software amounts to a non-competition restriction of unlimited duration. This is not justified by the usual development fees. If the developer cannot own or retain broad rights to use the concepts underlying the code, its skill level is frozen at the beginning of the project. This is an unreasonable restriction on the developer’s business, inevitably leading to higher development costs.

If the client owns the copyright, the developer cannot deliver the same or substantially similar code to anyone else. The client’s “lead-to-market” is thus reasonably protected. The developer must still develop original non-infringing code for the next client needing a similar system.

The developer should also own whatever patentable inventions result from its work. Inventions created by the developer are more likely to have been built upon the developer’s experience and know-how and relate to its business – information technology – than the client’s. The client should be licensed to practice the invention as reflected in the software. If the client pays for the patent rights, the developer should be licensed to practice the invention to enable it to enhance its competitive position in its market.

Any forfeiture of rights preventing the developer from using ideas, techniques and know-how specific to its information technology practice should be agreed to by the developer only if the developer is additionally paid for the resulting lost business opportunities.

Third Party Proprietary Software

The custom-developed software provided by the developer will often work with or include pre-existing software owned by third parties. The client will be licensed the right to use it by the vendor, or by the developer as authorized sublicensor. The vendor’s ownership of the software will usually not be at issue.

If third-party software requires custom modification for the client, and the client pays for it, ownership issues arise similar to those involved with custom developed code. In this situation, however, the copyright to the modification, a derivative work of the underlying program, should remain with the vendor. If the vendor relinquished the copyright, it would lose the ability to use the newly-created code in subsequent versions of its product.

If the third party software vendor further relinquished ownership of the modification’s underlying intellectual property rights, it might risk jeopardizing the trade secret status of its software, since the modification will likely reflect the base program’s trade secrets. The vendor should own and have unrestricted use of the modifications to its code, absent additional compensation beyond the costs of its development.

Developer Proprietary Software

In many cases, the developer will have preexisting proprietary software that may be useful to the client in operating the system. These may be application products or computer assisted system engineering (CASE) tools. The client’s right to use them will usually be stated in a separate license agreement with the developer. The discussion above regarding third-party vendor software and custom enhancements is relevant for any proprietary products supplied by the developer.

Conclusion

The developer, its client and third party vendors need to apportion ownership rights to a complex system’s various components to enable each to achieve their reasonable business objectives. This article summarizes only a few of the frequently arising issues and varying perspectives of the parties. The task of helping the parties resolve their competing interests – and putting it in writing – falls to the intellectual property/computer lawyer who understands the benefits his or her client should reasonably expect from its information technology investment.

3. Id.; 17 U.S.C. Sec 101; See also CCNV v. Reid, 109 S.Ct. 2166 (1989), which describes the analysis to determine copyright ownership of a specially commissioned work prepared by one not a formal salaried employee of the commissioning party.